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Through the Lens

Fusion – where macro and micro meet

11 December 2015

Relative value strategies for uncertain times

What will Europe yield?

China’s beef

We live in volatile times. Concerns about China, the debate over when the US Federal Reserve will raise rates and a huge emerging market sell-off are all creating uncertainty. Equity markets in particular have experienced pronounced swings in sentiment. Meanwhile, bond markets are no longer seen as relative safe havens.

A fusion of macro and micro insights

In our view, one possible solution to this uncertainty is to combine macroeconomic insights with micro alpha-generating ideas that can generate a positive return over a two- to three-year investment horizon – irrespective of the prevailing market conditions.

Thematic ideas come from fundamental economic research and analysis. These insights are then fused with traditional investments (equities, bonds, real estate), as well as more focused strategies. The latter allows us to profit from our views on interest rates, currency exchanges, volatility and inflation expectations. This includes relative value strategies that can make money irrespective of market direction.

Such breadth of investment insight provides excellent diversification, especially when compared to traditional investment vehicles or even more sophisticated products (equity long-short funds, for example). It also means investors can achieve a positive return with considerably less volatility than they would if they invested in global equity markets.

A strategy that pays dividends

How does this look in practice? One such return-generating macro/micro strategy we recently deployed was “European Dividends”. We recognised the growing popularity of structured products among yield-hungry European investors. This created a situation where banks that structure such products were long dividend risk. They therefore had to hedge this risk, particularly in times of upheaval. This resulted in EuroStoxx 50 dividend futures trading cheaply in all but the most extreme scenarios. A buy-and-hold to maturity strategy consequently allowed longer-term investors such as ourselves to access this anomaly and achieve a positive return.

Where’s the beef?

Another macro/micro strategy to highlight was based on rising demand for Brazilian protein. This has been driven by China, where higher wages have resulted in more meat consumption. This demand only looks set to continue: according to the OECD-FAO, purchases of beef in China will increase 4% annually by 2022.

Brazil, a major beef exporter, should therefore benefit from this growing market. It has swathes of excellent farmable land and bountiful water supplies, as well as a favourable cattle cycle and consolidation has created high barriers of entry. Furthermore, Brazil’s currency is weak and its labour market cheaper than countries such as the US (the world’s largest beef producer).

To exploit this potential, we therefore purchased a basket of USD-denominated cash bonds issued by the four main Brazilian protein producers: Minerva, BRF, JBS and Marfrig. Overall, this has proven to be a successful strategy.

Looking ahead

We expect markets to remain volatile over the coming months. In such conditions, we will continue to seek to exploit the opportunities that these macro and micro economic conditions present, building a portfolio capable of generating positive returns in a number of different scenarios.